Thumbs Down: An Unexpected Veto for the Merger of D&S and Falabella
No one anticipated what was in store in May 2007 when D&S, Chile’s largest supermarket chain – which also has a sizable share of the country’s financial and real estate sectors – and Falabella, a Chilean department store chain also active in finance, supermarkets, real estate and home improvement stores – announced with great fanfare that they were planning to merge into a single conglomerate.
When the news of the merger was announced, share prices for the two companies immediately shot up because the strategic hook-up would create the second-largest retailing group in the Latin American region, second only to Wal-Mart’s operations in Mexico. The new firm would have a market capitalization of more than $15 billion.
TDLC’s Review of the Merger
In June 2007, the two retailers presented their case for a merger before Chile’s TDLC, the Court for the Defense of Free Competition, the institution responsible for safeguarding free competition in the marketplace. As usual, the TDLC could either approve or reject the corporate merger proposal. From that day forward, the two companies began the dizzying task of presenting documents to the TDLC, in which they explained the objectives of their merger and outlined its positive impact on the market.
As the companies saw it, the efficiency of Falabella, which provides consumer credit cards, married with D&S’ skill in the supermarket sector, would trigger cost synergies and new economies of scale. “And all these gains in efficiency would generate additional savings by individuals, which would also benefit society,” argued a report called “Economic Analysis of the Merger between D&S and Falabella.” The report was prepared by Fernando Coloma, Juan Pabelo Montero and Jorge Tarzijan, all professors at the Catholic University of Chile’s economics department.
Their study also showed that the merger would provide the newly expanded company with greater opportunities to globalize their operations. “A greater capacity for globalization would lead to higher profits, and to benefits not only for foreign consumers and the owners of the merged firm, but also for some Chilean suppliers that would see their sales grow as a result of greater demand for their products as a result of this globalization process,” their report emphasized.
While the two players in the merger drew up their expansion plans, they were kept busy bringing documents to the TDLC in order to reveal how their merger would have favorable repercussions on the pocketbooks of local Chilean consumers.
An Unexpected Outcome
However, all of their efforts came to naught on January 31, 2008. To the astonishment of D&S and Falabella, the TDLC categorically rejected their merger application -- the first time that the TDLC had ever vetoed a corporate merger. Shares of both companies collapsed on the Chilean stock market, while local consumers rose up to applaud the court’s decision.
Miguel Mendoza, professor of economics and business at the University of Chile, notes that “The Chilean retail sector is already very concentrated. The more concentrated it becomes, the greater the tendency for monopolistic practices that have a negative impact on consumers. What’s more, the policy in more developed countries is to watch and see how concentrated markets become” after such acquisitions take place.
The integration of D&S and Falabella would have created a new company with a market share of about 22%. Its closest competitor would have been Cencosud, which has a 12% share. Clearly, this was the reason that the court, in its decision, said, “Carrying out this merger would lead to enormous change in the structure of the market, creating an enterprise that would be the dominant player in integrated retailing as well as in practically all of its segments (department stores, home improvement, supermarkets, real estate and associated financial businesses.)”
The regulatory body also established that high barriers to entry would make it very unlikely that a newcomer could enter the market and compete within a reasonable period of time. The TDLC added that the merger would “affect the purchasing decisions of Chileans and it would have harmful effects – in terms of well-being – on prices and on [both] the quantity and quality of products traded.”
Safeguarding Free Competition
According to Franco Parisi, professor of economics and business at the University of Chile, “The failure of the merger between D&S and Falabella effectively marks a new historic precedent because the TDLC had never rejected a merger. [This can] also be explained by the greater stakes for the players [in this case].”
Parisi dismisses the possibility that one day the court will set market quotas in areas where large companies have a significant presence, because that would mean “creating the law while looking at the past.” After this merger failed, there was a great deal of suspense in the retail sector. Most companies believe that the TDLC judgment opens the door for the court to go on and re-arrange the scene.
Parisi emphasizes that “the decision made [by the court] reflects the court’s concern for maintaining current conditions for competitiveness.” Mendozahas a similar view. He agrees that the essential premise of the court decision was “whether the merger would lead to a really competitive market structure, if the two companies – D&S and Falabella – were going to generate economies of scale that would enable them to operate at lower cost, and if those lower costs would benefit consumers.”
This case, Mendoza adds, “has demonstrated that the objective guiding the regulatory agency [TDLC] is to make sure that the market is working in the best possible way -- offering products and services at competitive prices that have a positive impact on the overwhelming number of consumers and never protecting the interests of any particular group.”
Determining the Risks Involved
Parisi argues that D&S and Falabella can learn several lessons from the court’s veto. “Companies that want to merge must do a better job of looking at past experience in this area, especially European experience. They must try to identify any measures that would enable them to block any efforts by the court to reject [their merger proposal], while making sure that any mitigating measures determined by Chile’s national economic court (FNE) are the kinds of measures that have less impact on their business.”
The FNE is a government entity whose mission is to assess whether economic conditions in the market are benefiting everyone as a whole. The prosecutor’s office supports the TDLC by providing reports that determine the risks involved in any business merger, and by recommending ways to mitigate those risks. The FNE’s recommendations are based on documentation provided by the companies involved in the merger and by research reports prepared by economists.
In the back-and-forth of this tennis match, the two corporate players had to supply information to the TDLC and to the FNE, which replied by demanding additional data. Mendoza says that companies can learn another big lesson from this case. “Clearly, both retailers lacked a communications strategy for reaching every stakeholder in the market and for communicating the goals and benefits of their [proposed] merger. Although the companies delivered the [requested] data and undertook research that provided justification for their merger, all of their efforts were aimed in just one direction – at the TDLC) and the FNE.”
Nowadays, organizations need to carry out a communications strategy that deals with every public interest group and participant in the market economy, as well as with their ultimate customers, says Mendoza. “In this particular case, the [two companies’] communications strategy should have included every governmental institution, opinion leaders, employees, shareholders, investors, suppliers, political leaders and civil leaders. In short, everyone who believes he is influenced by the corporation.”
The Next Steps
The TDLC’s veto of the merger forced both retailers to quickly modify their business strategies. According to Parisi, “Falabella is the company that has rebounded faster. It will expand through its supermarket subsidiary known as Tottus, which is opening new shops. Its prospects are strengthened by its commercial property business.”
Falabella is focusing on expanding its supermarket chain. It will open 50 new Tottus stores in both Chile and in Peru. Falabella (through Tottus) has had a significant presence ever since 1995. From 2008 through 2011, Falabella expects to reach a total of 80 stores, for an investment of $2.86 billion.
Industry analysts say its strategy “makes sense.” In the sectors where Falabella is currently active – mini-malls, home improvement centers, shopping centers – Falabella has become a leader. When it comes to supermarkets, there is room for it to continue growing. One of the goals of Falabella’s proposed merger with D&S was to strengthen its share of the supermarket sector.
As Parisi notes, “Falabella has followed a development strategy that involves incorporating retail [in the overall company], and that [approach] has brought it lots of success.” He believes that this formula will continue to be the foundation of its business.
As for D&S, Parisi explains that it “has been engaged in mergers and acquisitions ever since the mid-1990s…. It would not be strange for it to try to internationalize its operations as much as Falabella does.” D&S, which owns the supermarket brands Lider, Ekono and Bodega ACuenta, has a presence throughout Chile, so there is no room for it to grow more quickly there. Market analysts agree with Parisi, warning that D&S will embrace a strategy of penetrating foreign markets in order to keep growing.
Last year, D&S made an intensive effort to acquire Gigante, the Mexican retailer. Ultimately, Gigante was purchased by Soriana, another Mexican firm. Experts believe that D&S is likely to make another effort to penetrate Mexico, as well as Peru.